The Federal Reserve officially kicked off its rate-cutting cycle at the September meeting, reducing rates by 50 basis points to 4.75%-5%. This marked an aggressive start to the first easing campaign in four years, as policymakers gained greater confidence that inflation was moving sustainably towards the 2% target and amid an effort to head off a slowdown in the labour market.
In the days following the Federal Reserve cutting interest rates, the Dow Jones and the S&P 500 rose to record highs. A month after the rate cut, the Dow Jones and the S&P 500 have both reached numerous record highs, and the NASDAQ 100 has risen to its highest level since mid-July. Earnings season has started, and investors will be watching guidance closely to see how firms see a lower interest rate environment impacting sales and profits.
Lower interest rates often boost share prices for two reasons. Firstly, it is cheaper for the company to borrow and reinvest in the company to make it more profitable. Second, lower rates mean savings accounts and other investments are less attractive, so investors often move their money toward stocks.
Where next for US stock indices?
How stocks tend to react in the months after the Federal Reserve loosens monetary policy depends on whether the rate-cutting cycle has been associated with a recession or not. According to historical data of the 10 Federal Reserve rate-cutting cycles since the 1980s, four of these cycles have been associated with recession, and six have not. In the rate-cutting cycles, when the Fed managed to avoid a recession, stocks tended to rally, and when the Fed failed to prevent a recession, stocks tended to slide.
Can the US avoid a recession?
So, is the US heading for a recession or a soft landing? It is still early days. So far, data is pointing to a Goldilocks scenario whereby the economy remains resilient as inflation cools. The September non-farm payroll smashed expectations; retail sales are solid, and the service sector, the dominant US sector, remains firmly in expansion. Goldman Sachs has lowered its odds of a recession in the coming 12 months to just 15%, down from 20% in August. Meanwhile, the latest inflation data showed that consumer prices in the US eased to 2.4% year on year in September, down from 2.5% and the lowest level in three years.
What are the risks to the outlook for stocks?
This so-called Goldilocks scenario enables the Federal Reserve to continue cutting rates, which would support further gains in the stock market. However, there are risks to this outlook.
Firstly, there’s the risk that inflation starts to rise again, particularly given the resilience of the job market and solid household consumption levels. Furthermore, the recent rise in oil prices back above $70.00 a barrel could also add inflationary pressures.
The market has already discounted expectations of another 50 basis point rate cut in November and sees the Federal Reserve adopting a gradual pace of two rate cuts instead. Federal Reserve speakers have supported this view, with Atlanta Fed president Raphael Bostic recently saying that he sees one more 25 basis point rate cut this year.
Secondly, the US election brings a level of risk and uncertainty. Trump’s core policies on trade, tax, and immigration are considered inflationary and could prevent the Federal Reserve from continuing along its rate-cutting cycle in 2025. Meanwhile, Harris’s win could be viewed as a continuation of the Biden administration, which might be more favourable to the stock market. With just three weeks to go the race is still too close to call.
Trading indices with PXBT
There are many ways to benefit from changes in stock prices, from buying physical shares to trading them in an index form through an online brokerage such as PXBT.
Trading stock indices rather than single stock shares enables you to gain exposure to a broader range of sectors rather than one firm. This is one of the ways to manage risk.
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